There are four broad concepts that assist accountants in measuring, recording, and reporting financial accounting transactions.
Four Basic Accounting Principles
1. Historical Cost Principle: This is the original monetary value of an asset and liability. For an asset, it is the value of what was given in exchange for the asset at the time it was acquired. Asset values tend to appreciate over time but the use of the historical cost principle does not account for this. For a liability, it is the current cash equivalent received in exchange for the liability. Using the historical cost principle, on a balance sheet, assets and liabilities are noted at the value on the date of their original acquisition. However, this may not be their true value due to appreciation and depreciation. Although the use of this principle reflects some inaccuracy, it remains in use in most accounting systems.
2.Full Disclosure Principle: This is a commitment to provide all information necessary for users of financial statements in order to assist them in making sound financial decisions. Additional information like lawsuits or executive stock options that could have an effect on the future of the company is usually disclosed in footnotes in the financial statements.
3.Realization Principle: This principle acknowledges revenue when the product is delivered or the service completed. This principle, also known as revenue recognition, is a foundational principle in accrual accounting. It pays not regard to the timing of cash flow. Revenue recognition must meet the following three criteria. Most often, these criteria are met at the point of sale and/or delivery.
- The earnings process if complete
- There is reasonable certainty of the collectability of the asset to be received
- The exchange value can be determined
4.Matching Principle: This determines that expenses are recognized in the same period as the related revenue. It is the crossroads where accural accounting and revenue recognition meet. It is based on a cause-and-effect relationship between revenues and the expenses expended in creating the revenues.